Tenet Watchers Heed the Trouble Signs - TheStreet

After digesting

Tenet's

(THC) - Get Report

sour news this week, Wall Street is showing clear signs of heartburn.

Many analysts, unsettled by Tenet's Wednesday morning profit warning, now expect the company to report a bloody third quarter that's firmly in the red. In the meantime, they've slashed their earnings projections for Tenet -- generally in half -- for both this year and next.

Standard & Poor's also lowered Tenet's credit rating one notch deeper into junk territory on Thursday. The ratings agency, which cut Tenet to junk after an earlier earnings warning, now rates the company's debt at the speculative BB-minus level.

"The downgrade reflects even weaker-than-expected profitability and, as a result, possibly weaker liquidity at Tenet," S&P analyst David Pekney wrote Thursday afternoon. "These issues, in addition to other rating concerns of yet undetermined magnitude, indicate a credit profile more reflective of the lower rating."

S&P was just the latest in a series of firms to raise concerns about Tenet on Thursday. Bond and equity analysts alike issued dim updates, often as sickening as Tenet's own, to flush the latest surprises out of their system.

"We've run out of fingers and toes counting up these 'factors' that keep taking Tenet management by surprise," wrote Carol Levenson, a bond analyst at Gimme Credit, which ranks Tenet as a member of its "Bottom Ten List." "Surely, management ought to have seen this coming."

Tenet shares -- already pounded one day earlier -- took a fresh beating as Wall Street's dreary reports piled up. The stock, which fell 7% to $12.58 on Thursday, is now trading at its lowest level since the company issued its last earnings warning in July.

Push Comes to Shove

Like other analysts, Levenson is groaning about Tenet's sudden report Wednesday that bad debt from the uninsured would cause it to "significantly" miss both third-quarter and full-year earnings projections. The company, which has withdrawn all forward earnings guidance, also revealed that it had probably tripped a covenant tied to its only bank line.

Prudential analyst David Shove now expects the company to report a loss, rather than a profit, of 20 cents a share for the latest period. He's also halved his full-year estimates for both 2003 and 2004, cutting them to 48 cents a share and 50 cents a share, respectively. Yet another analyst, Banc of America's Gary Taylor, believes the company will generate no profits at all next year.

Like Shove -- who's been bearish on the company for a while -- Taylor now rates Tenet a sell and values its stock at just $10 a share. In a downgrade published Thursday, Taylor virtually apologized for failing to predict the worst before now.

"We could not understand how management would achieve its

second-half guidance ... if pricing trends did deteriorate this sharply," Taylor stated. "Management has now withdrawn that guidance, so perhaps we should have presented our initial skepticism earlier."

Levenson, for one, seemed less surprised by Tenet's latest profit warning.

"When ... Tenet Healthcare issued its previous earnings warning (which was not its first of the year), we observed that perhaps management ought to consider getting out of the earnings projection game entirely," Levenson wrote. "It seems our advice has been heeded."

Unpredictability

Still, Levenson saw clear reasons for alarm. She expects Tenet to report a $100 million loss, rather than profit, for the third quarter. She believes bad debt could materially affect future cash flow. And she's even concerned about the tripped loan covenant that, in the end, she expects Tenet to resolve.

"Tenet is in talks with its banks about a waiver, but we note the agreement was amended in April to

tighten

the leverage covenant," Levenson wrote. "It's the unpredictability and the negative trend in debt protection measures that continue to concern us. ... We don't believe the mild bond-market reaction to this news reflects the increased risk here."

Right now, analysts still believe Tenet can escape a liquidity crisis. But they nevertheless question why the company is down to its last $200 million after raking in more than three times that amount from recent asset sales. And Shove, for one, believes the company must keep peddling hospitals if it even hopes to recover.

"With industry trends harshly buffeting the company, Tenet's turnaround prospects have diminished significantly," Shove wrote. "So far, Tenet management's efforts to implement incremental change are not working. Consequently, we think Tenet should be considering actions such as additional hospital sales or formal reorganization."

In the meantime, analysts are already bracing for more bad news ahead. Taylor, for example, pointed to at least three different scenarios that could pressure Tenet's earnings even further. For one, he views Tenet's current malpractice reserves as less than adequate. He also suggests that Tenet's "aggressive" depreciation techniques are boosting profits by 14 cents a share annually. And he warns that Tenet may have over-billed Medicare -- for more than just "outlier" reimbursements -- and could suffer going forward as a result.

Tenet is already under investigation for its past outlier billing, despite a "voluntary" move to tone down its practices this year. The company also faces multiple probes for allegedly performing unnecessary surgeries, paying illegal kickbacks to physicians and bilking other government insurance programs.

From the beginning, Shove has dwelled on these probes as serious areas of concern. And Tenet's ability to look past these challenges -- excluding any settlements or lawsuits from forward guidance -- only troubles him further.

"In 2Q03, Tenet paid $68 million or 2% net revenues on legal and investigation costs!" Shove noted, echoing the same observation made by

TheStreet.com

one day earlier. But "Tenet did not provide guidance on legal and investigation costs such as attorney fees."

Ultimately, Shove questions whether Tenet can weather the current storm.

"With no visibility and weakening assets, will there be enough for the banks, lawyers and fines?" he asked. "Tenet will need to improve dramatically its earnings and operating cash flow before the lawyers and fines come due. This is no small challenge, in our view."